India Payroll Compliance for Foreign Employers: PF, ESI, TDS, Gratuity & Labour Codes Explained

Can a Foreign Company Pay Indian Employees Directly Without a Local Entity or EOR?

Foreign employers cannot legally run a direct local Indian payroll or deduct statutory contributions without an incorporated Indian legal entity or an Employer of Record (EOR). Operating without a local legal presence while directly controlling local personnel creates severe Permanent Establishment (PE) tax exposure and compliance risks under Section 9 of the Income Tax Act (opens in a new tab).

When an overseas business hires talent in India, Indian employment law requires local tax withholding, statutory social security remittances, and mandatory reporting. If a non-resident corporate entity makes direct wire transfers from a foreign bank account to Indian residents without registering a local establishment, the Income Tax Department can deem the foreign parent company to have a Permanent Establishment in India. This subjects the foreign company’s global income attributed to Indian operations to the foreign company tax rate of 35% (plus applicable surcharge and cess).

Foreign employers must choose between two primary operational pathways to maintain full legal compliance:

1. Incorporating a Foreign Subsidiary (Wholly Owned Subsidiary / WOS): Ideal for long-term investments with teams exceeding 15-20 employees. This requires local corporate registration via the Ministry of Corporate Affairs (MCA), Permanent Account Number (PAN), Tax Deduction and Collection Account Number (TAN), and statutory payroll registrations.
2. Engaging an Employer of Record (EOR): An established third-party Indian entity acts as the legal employer on paper, managing localised employment contracts, monthly payroll runs, tax withholdings, and statutory filings, while the foreign parent company manages day-to-day work tasks.

Field note: the direct wire trap

We regularly advise overseas leadership teams who initially attempt to pay people in India via direct USD SWIFT transfers tagged as “consultancy fees.” Within 12 to 18 months, these workers often face tax audit notices for underpaying advance taxes or failing to account for Goods and Services Tax (GST) under the reverse charge mechanism. Moving misclassified “foreign contractors” onto an EOR or an Indian subsidiary requires retroactively auditing back-pay, issuing Form 16s, and restructuring historical salary stacks to avoid steep non-compliance penalties.

How Do Provident Fund (PF) and Employees’ State Insurance (ESI) Apply to Foreign Employers?

Statutory social security in India requires both employer and employee contributions calculated as specific percentages of qualifying monthly wages. Under statutory frameworks maintained by the Employees’ Provident Fund Organisation (opens in a new tab), Provident Fund (PF) applies to establishments with 20 or more employees, while Employees’ State Insurance Corporation (opens in a new tab) coverage mandates participation for entities employing 10 or more workers under eligible salary thresholds.

1. Employees’ Provident Fund (EPF)

The EPF scheme provides retirement savings, insurance, and pension benefits:

• Coverage Threshold: mandatory for establishments with 20 or more employees.
• Contribution Breakdown: The employer contributes 12% of qualifying wages, and the employee contributes a matching 12%.
• Wage Ceiling: From 17 September 2026 the ceiling is ₹25,000 a month (it was ₹15,000), so each side’s required contribution is at most ₹3,000 a month. Our guide to the new PF wage ceiling covers what changed.
• Allocation: Out of the employer’s 12% contribution, 8.33% goes to the Employees’ Pension Scheme (EPS) (capped at a statutory ceiling wage), and the remaining 3.67% goes to the employee’s EPF account.
• International Workers (IWs): Expatriate employees holding non-Indian passports working for an Indian entity are classified as International Workers. Unless they originate from a country with which India has an active Social Security Agreement (SSA), PF applies to their total gross basic salary without the statutory cap.

2. Employees’ State Insurance (ESI)

ESI provides comprehensive healthcare, sickness, and disability coverage:

• Coverage Threshold: Applies to establishments with 10 or more employees.
• Salary Limit: Mandatory for employees earning a gross monthly wage up to ₹21,000.
• Contribution Rates: The employer contributes 3.25% of gross pay, while the employee contributes 0.75%, totaling 4.00%.

How Does the 50% Basic Wage Rule Under the Labour Codes Reform India Salary Structuring?

The unified Code on Wages standardises the legal definition of “wages,” mandating that Basic Salary plus Dearness Allowance must constitute at least 50% of an employee’s total Cost to Company (CTC). Restructuring away from historically allowance-heavy packages directly increases the wage base used to compute employer statutory obligations under guidelines issued by the Ministry of Labour and Employment (opens in a new tab).

Historically, employers in India minimised PF and Gratuity liabilities by capping basic wages at 20%-30% of CTC and packing the remaining 70%-80% into discretionary categories (House Rent Allowance, Special Allowance, Conveyance, and Medical Allowance). Under the consolidated Labour Codes framework, if non-wage allowances exceed 50% of total compensation, the excess amount is automatically added back to the wage definition for statutory calculations.

Salary Restructuring Impact: Pre vs. Post Wage Code

As shown above, while the total CTC remains unchanged at ₹1,000,000, shifting the Basic Wage from 30% to 50% substantially increases the employer’s statutory outlays for Provident Fund and annual Gratuity accruals.

What Are the TDS (Tax Deducted at Source) and Professional Tax Obligations for Overseas Employers?

Employers in India act as tax collection agents for the government, required to compute and withhold income tax under Section 192 of the Income Tax Act prior to dispersing monthly salaries. The official procedures published by the Income Tax Department (opens in a new tab) require employers to deposit withheld tax monthly and issue annual tax certificates to staff.

1. Tax Deducted at Source (TDS under Section 192)

• Regime Selection: Employees can choose between the Old Tax Regime (which permits deductions like HRA, 80C investments, and home loan interest) and the Default New Tax Regime (featuring lower slab rates but fewer exemptions).
• Monthly Remittance: Withheld TDS must be deposited with the Central Government by the 7th day of the following calendar month (30th April for March withholding).
• Quarterly Returns: Employers must file quarterly TDS returns in Form 24Q within 31 days of the end of each fiscal quarter.
• Form 16 Issuance: Employers must issue Form 16 (Annual Tax Certificate) to all employees by June 15th following the end of the financial year.

2. State-Specific Professional Tax (PT)

Professional Tax is a state-level levy imposed on trades, callings, and employment under state legislation (e.g., Maharashtra, Karnataka, Tamil Nadu, Telangana).

• Deduction Rates: Rates vary by state, capped at a maximum of ₹2,500 per employee per annum.
• Registration: In states that levy it, employers register to deposit the tax deducted from employees and enrol to pay the entity’s own annual tax; in Maharashtra these are the Professional Tax Registration Certificate (PTRC) and the Professional Tax Enrolment Certificate (PTEC).

How Are Gratuity, Leave Encashment, and Full & Final (FnF) Settlements Calculated Under the 2-Day Mandate?

Under Section 17(2) of the Code on Wages, all unpaid wage components of a Full and Final (FnF) settlement must be disbursed within two working days of an employee’s separation due to resignation, dismissal, retrenchment, or contract termination. This mandate, supported by regulatory policies from the Ministry of Labour and Employment (opens in a new tab) and the Employees’ Provident Fund Organisation (opens in a new tab), compresses traditional 30-to-45-day exit settlement cycles down to 48 hours.

1. Gratuity Benefit Calculation

Gratuity is a statutory lump-sum payment acknowledging long-term service:

• Eligibility: Mandated upon completion of 5 years of continuous service (waived in cases of death, permanent disability, or expiration of fixed-term employment).
• Formula: Gratuity = (15/26) x Last Drawn Basic Wage x Tenure (Years of Service)
• Statutory Limit: Maximum tax-free gratuity exemption stands at ₹2,000,000 (20 Lakhs).

2. Leave Encashment

Unused Earned Leave (Privilege Leave) accrued up to the last working day must be monetised during separation. The calculation evaluates daily basic wage equivalents across eligible unused leave days.

Field note: meeting the two-day FnF deadline

Foreign HR leaders operating across opposing time zones often struggle to complete cross-department clearances (IT asset recovery, manager handovers, corporate card expense reconciliations) within the mandatory 2-day window. To remain compliant, companies must implement a pre-exit clearance framework. Once an employee submits a resignation notice, asset collection logistics, IT access revocations, and leave balance reconciliations should be triggered during the notice period, so the payroll engine executes the final financial wire within 48 hours of the employee’s last physical working day.

What Is the Practical Compliance Checklist for Foreign Companies Operating in India?

Overseas employers maintaining Indian talent must coordinate state-level registrations, monthly tax deposits, and structured filing calendars. Adhering to unified regulatory schedules overseen by the Ministry of Labour and Employment (opens in a new tab) prevents interest penalties, statutory fines, and compliance notices.

Recurring Statutory Compliance Calendar

Employer Registration Setup Checklist

• Obtain Indian Entity Incorporation / MCA Registration or partner with an established Employer of Record (EOR).
• Secure Corporate PAN (Permanent Account Number) and TAN (Tax Deduction Account Number).
• Register for EPF portal access and generate establishment code (mandatory at ≥ 20 staff).
• Complete ESIC online portal registration (mandatory at ≥ 10 staff).
• Register under state Shops and Establishments Acts across each state where remote staff reside.
• Obtain State Professional Tax Registration (PTRC and PTEC).
• Align employment contract templates with the 50% Basic Wage definition and notice period clauses under the consolidated Labour Codes.

With Bridge91 as your Employer of Record, these registrations and filings are ours to carry: we run payroll in rupees and file PF, ESI, professional tax, TDS (Form 24Q, Form 16), gratuity and Shops and Establishments.

Frequently Asked Questions About India Payroll Compliance

What happens if a foreign employer fails to pay FnF within 2 working days?

Failing to settle final wages within 2 working days of separation violates Section 17(2) of the Code on Wages. Employers face statutory interest penalties ranging from 12% to 18% per annum on delayed payments, alongside potential inspections and fines imposed by state labour authorities.

Is Gratuity mandatory for fixed-term contractors in India?

Yes, under the Code on Social Security, fixed-term employees are eligible for gratuity on a pro-rata basis if they complete one year of continuous service. This updates the previous 5-year requirement that applied exclusively to permanent personnel.

How does the 50% basic wage rule impact net take-home salary for Indian staff?

Increasing the Basic Wage to 50% of total CTC elevates monthly PF contributions (which are matched by the employee). As a result, an employee’s gross monthly take-home salary may slightly decrease, while their retirement savings and gratuity payouts increase proportionately.

Can an overseas company pay salaries in foreign currency (USD/EUR) directly to Indian residents?

No, Indian residents working within national borders must receive their salaries in Indian Rupees (INR) into local Indian bank accounts. Payments must flow through an Indian entity or an EOR to guarantee proper TDS, PF, and Professional Tax deductions.